The Decade’s 12 Greatest Developments in Payments: #4 PayPal

The New Kid on the Block: PayPal

Starting a new payment system is incredibly difficult. Many try, few succeed. MasterCard and Visa did it in the 1960s. No one did it in the 1970s at least in the US. Sears brilliantly did it with Discover in the 1980s. The 1990s was a miss.

For this decade the only company that entered the exclusive club of major payment systems was PayPal. As of 2008, $60.1 billion of transaction flowed through this online payment system. That’s significantly behind the total transaction volume that went through Discover that year ($92.4 billion) but ahead of that for USAA Savings ($49.4 billion) based on data from the Nilson Reports which put those two financial institutions in positions 8 and 9 (based on credit, debit and prepaid transactions). More than half of the transaction volume came from merchants that were not selling on PayPal’s home base of eBay. PayPal had 68 million active accounts in 2008. By way of comparison Discover had about 50 million cardholders and American Express had about 92 million. PayPal has more than 3 million merchants (mainly the ones that sell on eBay) that accept PayPal.

Like all payment systems PayPal acts an intermediary between merchants and consumers. What makes it different is that it acts as a wallet in which consumers provide information for one or more of their electronic methods of payment such as a credit card or checking account. In the scary world of electronic commerce where consumers cannot be sure whether a merchant is legitimate or a Bulgarian front, and where merchants worry about chargeback and many other kinds of fraud with card-not-present transactions, PayPal provides a buffer and security. Consumers don’t give the merchants their card info, and merchants have the comfort of dealing with someone with a regular PayPal relationship. This helped ignite eBay, which bought PayPal in 2002, to ignite its marketplace.

Successful intermediaries reduce frictions in the economic system. That’s what PayPal did with aplomb. Merchants could sign up to receive payments for their online sales in minutes while cardholders simply had to provide their email addresses and account information. After that consumers could pay with just their password and a few clicks and merchants didn’t have to worry about all of the details of online payments. Its big challenge in its early days was mastering online fraud and beating back organized crime. The story of PayPal has been told a lot so I can be brief. Remember back in the late 1990s the hot toy was the Palm Pilot. The initial idea for PayPal was to provide a way for people to beam money (the latest model of the Pilot had infrared) to each other. Like all subsequent efforts to date to find the pot at the end of the P2P rainbow this one failed. But in the process the company found that its companion online method, started as a btw, was pretty handy. The rest is history; see Eric Jackson’s The PayPal Wars for a good rendition by an early PayPaler.

As it goes into its second decade, it remains to be seen whether PayPal will achieve its promise of becoming a general purpose online payment system. As all of us online shoppers know that it is a real pain in the butt to buy things online at most merchants. After you’ve selected your shiny new toy you are generally faced with an absolutely daunting form, sent scurrying for your cards, and have a nagging suspicion, even if you know better, that some computer-savvy thug will steal your identify and sack your lifesavings. PayPal is so much simpler and safer. As of the end of 2009, off of eBay, PayPal has gotten 5,600 merchants to sign up to allow customers to pay with their PayPal accounts. That’s not nada, and these merchants now account for around half of PayPal’s transaction volume. But it’s a pretty puny number in the payments business and a quick tour through the merchant directory finds does not uncover many significant e-tailers. The problem is that merchants, like Brooke Shields and her jeans, don’t want anything between them and their customers. PayPal takes customers off-site and inserts PayPal branding on the bill. If PayPal doesn’t figure out a way around this someone else will almost surely end up as the payment wallet, used by merchants and consumers, on the Web.

Nevertheless, while PayPal could always do more, it has accomplished an incredible amount in less than a decade.

Previous Great Developments in Payments During the Last Decade:


#5 Innovation Driven by Prepaid Cards

#6 What Has a Bigger Head and Longer Tail? Card Issuing

#7 How the ACH System in the U.S. is Encouraging Electronic Payments Innovation

#8 The Magstripe Lives On

#9 Shanghai Surprise

#10 Collateral Damage from the Financial Crisis – Consolidation and Regulation

#11 How the World War on Interchange Fees Transformed the Card Industry

#12 American Express Goes Global

David S. Evans bio